Annual Report 2012 Read the online Annual Report at

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1 Annual Report Read the online Annual Report at

2 Proud history, bright future Who we are British American Tobacco is a leading tobacco group, with brands sold in around 180 markets. We employ more than 55,000 people and, with over 200 brands in our portfolio, we make the cigarette chosen by one in eight of the world s one billion adult smokers. Founded in 1902, our Group of companies traded through the turbulence of the 20th century, including wars, revolutions and nationalisations. The Group was first listed in 1912, and today we are one of the top 10 companies listed on the London Stock Exchange and feature in the Fortune 500. We have also had a secondary listing on the JSE Limited in South Africa since We hold robust market positions in each of our four regions Americas; Asia-Pacific; Eastern Europe, Middle East and Africa; and Western Europe and we are leaders in more than 60 markets. Our approach to marketing is second to none in our industry, in brand building, innovation and responsibility. Our companies adhere strictly to the high standards of our voluntary marketing principles. In, our subsidiaries enabled governments worldwide to gather more than 30 billion in duty, excise and sales taxes on our products, more than seven times the Group s profit after tax. We play a significant role in local communities around the world. In many countries we are a top employer and the company of choice for people in all areas of our business. We have 44 cigarette factories in 39 countries. In addition to cigarettes, we make cigarillos, roll your own and pipe tobacco. We are also proud of our Research & Development facilities, where our people are striving to reduce the harm associated with tobacco products. With our geographic diversity, strong brands, talented people and proven strategy, the Group is well placed to achieve further success. In particular, we are confident that our investments in both innovative cigarette products and next-generation nicotine and tobacco products will help us drive growth and build shareholder value in the years ahead. Our leading brands Our four leading brands are Dunhill, Kent, Lucky Strike and Pall Mall our Global Drive Brands (GDBs). Dunhill s roots date back to 1907, where Dunhill Tobacco of London Limited was established on Gentlemen s Row. More than a century later, Dunhill is our premium international brand, embodying the perfect taste, always. Since its establishment in 1952, Kent has stood for a modern, progressive cigarette. Relaunched in 1997, it has grown very quickly in popularity, backed by innovative product offers. Based on its rich legacy dating back to 1871, Lucky Strike is the true American original, now a popular choice throughout the world with a presence in more than 80 countries. Pall Mall is the third biggest cigarette brand in the world, sold in over 110 markets. For more than 110 years its core proposition has been centred on rewarding smokers globally with real, high quality value offers. We have many other famous international and local brands, including Rothmans, Vogue, Viceroy, Kool, Peter Stuyvesant and Benson & Hedges. References in this publication to British American Tobacco, we, us, and our when denoting opinion refer to British American Tobacco p.l.c. and when denoting tobacco business activity refer to British American Tobacco Group operating companies, collectively or individually as the case may be.

3 Contents Directors report Business Review 2 From the Chairman 4 Our year in numbers 6 Chief Executive s review 8 Global market overview 10 Our strategy to deliver shareholder value 12 Our business model 14 Strategic review 22 Sustainability overview 24 Chief Operating Officer s review 26 Asia-Pacific 27 Americas 28 Western Europe 29 Eastern Europe, Middle East and Africa (EEMEA) 30 Financial review 39 Key Group risk factors Corporate Governance 46 Chairman s introduction 47 Leadership and governance 48 Board of Directors 52 Board effectiveness 53 Strategic Board activities in 56 Board evaluation 58 Audit and accountability 64 Corporate social responsibility 67 Appointments to the Board 69 Remuneration report 99 Other statutory and regulatory information 106 Responsibility of Directors Financial statements and other information Group Financial Statements 107 Independent auditors report 108 Group Income Statement 109 Group Statement of Comprehensive Income 110 Group Statement of Changes in Equity 111 Group Balance Sheet 113 Group Cash Flow Statement 114 Notes on the accounts 188 Five-Year Summary 189 Half-Yearly Analyses of Profit 190 Principal subsidiary undertakings 191 Principal associate undertakings Parent Company Financial Statements 192 Independent auditors report 193 Balance Sheet British American Tobacco p.l.c. 194 Notes on the accounts Other information 197 Shareholder and contact information British American Tobacco p.l.c. (No ) Annual Report This is the Annual Report of British American Tobacco p.l.c. (the Company) and the British American Tobacco Group, comprising the Directors report and the audited financial statements, for the year ended 31 December. It has been drawn up and is presented in accordance with, and reliance upon, applicable English company law. The liabilities of the Directors in connection with this report shall be subject to the limitations and restrictions provided by such law. The Annual Report is published on A printed copy is mailed to shareholders on the UK main register who have elected to receive it. Otherwise, shareholders are notified that the Annual Report is available on the website and will, at the time of that notification, receive a short Performance Summary (which sets out an overview of the Group s performance, headline facts and figures and key dates in the Company s financial calendar) as well as a Notice of Annual General Meeting and Proxy Form. Specific local mailing and/or notification requirements will apply to shareholders on the South African branch register. Cautionary statement The business review and certain other sections of the Annual Report contain forward-looking statements that are subject to risk factors associated with, among other things, the economic and business circumstances occurring from time to time in the countries and markets in which the Group operates. It is believed that the expectations reflected in these statements are reasonable but they may be affected by a wide range of variables that could cause actual results to differ materially from those currently anticipated. British American Tobacco Annual Report 1

4 Business Review From the Chairman Dear Shareholder Let me welcome you to the Annual Report for. This has been a good year for your Company notwithstanding the challenging economic environment and the adverse impact of exchange rates. Since the Group was first listed in 1912, the business has developed and grown significantly, becoming recognised as one of the UK s leading companies. Today we are among the top 10 companies listed on the London Stock Exchange. Strong performance British American Tobacco delivered strong profit growth in, achieved through good pricing and an outstanding improvement in operating margin, partially offset by adverse exchange rate movements. To grow underlying market share and operating profit, while investing for the long term, is a strong sign of the efficacy of our strategy. Difficult trading conditions persist in parts of the world, particularly southern Europe, but these results demonstrate the Company is in excellent shape and we remain confident that our strategy will continue to deliver superior shareholder returns. Delivering shareholder value Our financial highlights indicate how the business is delivering superior returns. You can read a full summary of our successful year on the following pages. This success is reflected in adjusted diluted earnings per share for rising to 207.5p, an increase of 7% on last year. The Board has recommended a final dividend of 92.7p per share, which will be paid on 8 May 2013 to shareholders on the register at 15 March This takes the total dividend for the year to 134.9p, an increase of 7% on last year, and maintains our target of paying out 65% of sustainable earnings in dividends. The Board also approved the continuation of our share buy-back programme in. Between the beginning of March and the end of December, almost 39 million shares were repurchased at a value of 1.25 billion, excluding transaction costs. The Board has agreed a 1.5 billion share buy-back programme for Governance We are a leading international business, with products sold in 180 countries around the world. And, of course, we operate in a highly regulated sector that many regard as controversial. Acting responsibly makes good business sense and we set high standards for ourselves, our suppliers and our trade customers. Our values, a key component of our culture, are clearly embraced by our people and we take great care to ensure that they are embedded throughout the business. This needs good governance and, for us, this is not simply an exercise in compliance, it is a key element underpinning the sustainable, long-term growth of our business. A full report on our corporate governance is set out on pages 46 to 57. Historical total shareholder return Growth in the value of a hypothetical 100 holding in British American Tobacco over five years FTSE comparison is based on spot daily values Dec 07 Dec 08 Dec 09 Dec 10 Dec 11 Dec 12 British American Tobacco FTSE 100 Over the five-year period our compound growth rate, based on adjusted diluted earnings per share, has been 13.9%. 2 British American Tobacco Annual Report

5 Business Review Sustainability British American Tobacco was the first tobacco company to publish a social report and I am proud to say that more than a decade later we maintain our strong reputation for corporate social responsibility and sustainability. We were selected for the 11th successive year in the Dow Jones Sustainability Indexes, which recognise economic, social and environmental performance. We were also ranked in the top quartile of companies in a study on Transparency in Corporate Reporting: Assessing the World s Largest Companies carried out by Transparency International, a leading anti-corruption organisation. You will see that some of the progress we have made in against our sustainability agenda is discussed in this Annual Report, in particular within our strategic review and our corporate governance statement. We have also published a separate Sustainability Summary report Sustainability: why it matters alongside our Annual Report. This outlines our progress and explains how we are developing an ambitious new sustainability agenda that will better measure and address the impact our business has on its environment and stakeholders. You can download this summary report from our corporate website at highlights Adjusted diluted earnings per share improved by 7% to 207.5p Recommended total dividend for the year of 134.9p, up 7% on Selected for the Dow Jones Sustainability Indexes for the 11th successive year Share buy-back programme set at 1.5 billion for 2013 On track for further success Reflecting on the success of, let me express my thanks and appreciation to my fellow Directors on the Board, to our Chief Executive, Nicandro Durante, to management, and to all our colleagues around the world. In particular, I record our appreciation to Sir Nicholas Scheele and Robert Lerwill, both of whom will be standing down as Non-Executive Directors at the end of this year s Annual General Meeting, each having served eight years on your Board. I am delighted to welcome Brigadier General (retired) Dr Richard Tubb, a US citizen, who joined your Board on 28 January Richard is a prominent and well respected expert in the field of tobacco harm reduction and his appointment further demonstrates our commitment to putting science at the heart of our business. Looking forward, I am confident that we have the strategy, people and resources to continue to deliver high single figure earnings per share growth in the years ahead. Richard Burrows Chairman British American Tobacco Annual Report 3

6 Business Review Our year in numbers Group cigarette volumes, excluding associates (billion) % Revenue at constant exchange rates 2 (illion) 15,999 +4% Revenue (illion) 1 5,190-1% Profit from operations 1 (illion) 5, % Adjusted profit from operations 1 at constant exchange rates 2 (illion) 5,970 +8% Free cash flow (illion) 3,259-2% Basic earnings per share (pence) % Adjusted diluted earnings per share 1 (pence) % Dividends per share (pence) % 10 year dividend per share (pence) 1 January 2003 to 31 December Total shareholder return (annual %) FTSE January 2010 to 31 December The FTSE 100 comparison is based on three months average values Median 9.2% British American Tobacco 23.1% % Upper quartile Lower quartile 23.1% Notes: 1 Adjusted profit from operations is derived after excluding the adjusting items from the profit from operations. These adjusting items include restructuring and integration costs, amortisation and impairment of trademarks and similar intangibles, goodwill impairment and the Fox River provision. 2 Constant currency provides the information based on a re-translation, at prior year exchange rates, of the current year information. 4 British American Tobacco Annual Report

7 Business Review An overview of our performance We have a wide range of measures and indicators by which the Board assesses performance. To ensure management s focus is aligned with the interests of our shareholders, our KPIs (key performance indicators shaded in the table below) are reflected in our management incentive schemes. Although our other business measures listed here are not directly included in these incentives, we believe they improve the quality of our business and contribute to shareholder value, particularly over the long term. We review our business measures periodically and update them to ensure they remain relevant and reflect the needs and priorities of the business. Total shareholder return (TSR) annual % We measure our TSR against the FTSE 100 Index and our fast moving consumer goods peer group. Adjusted diluted earnings per share (EPS) Our target is to grow adjusted diluted EPS at the rate of high single figures per annum. Group s share of key subsidiary markets (increase in % share) Growth in the Group s retail market share in our Top 40 markets, as adjusted. Global Drive Brand (GDB) volumes Volumes of our GDBs Dunhill, Kent, Lucky Strike and Pall Mall sold by our subsidiaries. Total cigarette volumes Volumes of all cigarettes sold by our subsidiaries. Adjusted profit from operations at constant exchange rates Figure is derived after excluding the adjusting items (see note 1 opposite). Cash generated from operations The free cash flow excluding restructuring costs and dividends and other appropriations from associates, per the alternative cash flow. Operating margin This is the percentage of adjusted profit from operations divided by revenue. performance Further information 23.1% Page p +7% Page % Page 15 +3% Page bn -1.6% 5,970m +8% 2,739m Target exceeded 37.4% (: 35.8%) Page 15 Page 17 Page 17 Page 17 Free cash flow as a percentage of adjusted earnings This measures our free cash flow as a ratio of the adjusted earnings. Our target is to maintain a percentage figure of over 80%. Employee engagement index Our aim is to achieve a more positive score than the norm for the FMCG companies in our comparator benchmark group. Carbon dioxide equivalent (CO 2 e) tonnes per million cigarettes equivalent Our objective is to reduce Group CO 2 e by 50% by 2030 from our 2000 baseline and by 80% by Group energy use gigajoules per million cigarettes equivalent Our objective is to reduce energy use by 17% by 2017 from our 2007 baseline. Water use cubic metres per million cigarettes equivalent Our objective is to reduce water use by 26% by 2017 from our 2007 baseline. Waste to landfill tonnes per million cigarettes equivalent Our objective is to sustain waste sent to landfill at no more than tonnes per million cigarettes equivalent produced. Recycling percentage of waste re-used or recycled against waste generated Our objective is to re-use or recycle more than 85% of waste generated in each year. Lost Workday Case Incident Rate (LWCIR) The local objective set for all of our companies is zero accidents, and we have a zero accidents ambition for the whole group. 81% (: 86%) 72% (: 68%) 0.81 (2000: 1.38) (2007: 11.82) 3.77 (2007: 4.85) (2007: 0.025) 92.5% (: 85.4%) 0.23 (: 0.26) Page 17 Page 18 Page 20 Page 20 Page 21 Page 21 Page 21 Page 21 British American Tobacco Annual Report 5

8 Business Review Chief Executive s review Very good business performance We exceeded all of our financial objectives in. We delivered organic revenue growth on a constant currency basis of 4% and adjusted profit from operations of 8% at constant rates of exchange. Despite the adverse exchange rates, once again we delivered excellent returns to shareholders, with adjusted diluted earnings per share up by 7% on last year, with an increase of 12% at constant exchange rates. We grew our underlying market share in, with good share momentum in the second half of the year. Pricing remains strong and, while our cigarette volumes were down slightly, this was mainly due to industry declines in some of our major markets. Outstanding operating margin improvements We achieved a substantial improvement in operating margin of 160 basis points, exceeding our target of increasing operating margin by 50 to 100 basis points each year. In addition to a strong price mix of 6%, we have continued to focus on productivity improvements, addressing our cost base through factory rationalisation, systems standardisation and productivity savings. Innovations driving growth Our Global Drive Brands (GDBs) Dunhill, Lucky Strike, Kent and Pall Mall continued to perform well, driven by our innovations, recording both volume and share growth. We saw outstanding volume growth of 11% for Lucky Strike in. Dunhill volumes grew by 2%, Kent by 1% (or 4% adjusting for the one-off comparator in Japan) and Pall Mall by 3%. Collectively, our four GDBs achieved volume growth of 3% (or 4% excluding the impact of Japan) and now account for over one-third of our total volumes. GDBs grew market share by 30 basis points. Fine Cut tobacco, a category that includes roll-your-own and make-your-own, grew volume by 8% in Western Europe and increased market share. This was driven by Pall Mall, by far the largest brand in this category. Consumer focus Improving the execution of our strategy starts and ends with our focus on the consumer. Marketing products that satisfy a wide range of consumer needs has been key to our recent success and will become ever more important in the future. This consumer focus also extends to our efforts to improve productivity through a flexible and efficient supply organisation. This will enable us to release funds to invest in our brands and innovations, helping us grow market share and deliver higher returns for shareholders. Next-generation products Alongside the innovations in the cigarette market, we are developing next-generation products. Nicoventures, a company we set up in, is aiming to launch nicotine-based products and, in December, we acquired CN Creative, a UK-based company specialising in the development of electronic cigarette technologies. Great people Our continuing success is only possible thanks to our talented people, excellent teams and great leaders driving our organisation. I was very pleased to see that, in our latest employee opinion survey in, the percentage of our people who are extremely satisfied with British American Tobacco as a place to work was significantly higher than in our peer group. Sustainability at the heart of our business We continue to raise standards within our supply chain, market our products in a responsible way and strive to reduce the impact of tobacco use on public health. For me, this is a simple point. To grow our business we must operate sustainably creating shared value for our shareholders and society in a challenging and changing landscape. Our efforts in these areas have received positive recognition externally, but there is more we can do. In the year ahead, we will be working with stakeholders to develop a new sustainability agenda that increases our ambition and better measures the impacts of our business. Trafficking tobacco and regulation We support regulation backed by robust evidence showing that it will help achieve the objective of reducing the impact of tobacco use on public health. Measures such as excessive excise increases, retail display bans and plain packaging do more to disrupt orderly markets and little to further their intended aims. In fact they play into the hands of criminals by creating ideal conditions for the counterfeiters and smugglers to thrive. The illegal trade in counterfeit and smuggled goods accounts for around 12% of the global marketplace. This is a competitor that has no regard for playing by the rules, no incentive for maintaining quality and no qualms about selling tobacco products to the underaged. Where possible, we are in the front line in the battle against tobacco trafficking working alongside law enforcers, customs officials and international organisations, as well as making our packs easier to trace and harder to counterfeit. Management Board changes Ricardo Oberlander joined the Management Board at the start of 2013 as Regional Director, Americas, replacing Jack Bowles, who moved to our Asia-Pacific region. At the same time, Naresh Sethi was appointed Regional Director, Western Europe. On 1 March 2013, Alan Davy was appointed to the position of Group Operations Director, replacing Des Naughton, who took on the new role of Managing Director Next-Generation Products, encompassing Nicoventures and CN Creative. I would like to congratulate Ricardo, Jack, Naresh, Alan and Des on their new roles on our Management Board. 6 British American Tobacco Annual Report

9 Business Review Challenges and opportunities ahead Our geographic diversity, powerful brands, investment in innovations and strong positions in emerging markets remain key strengths and we are confident in the future of the tobacco business. We also believe that building a portfolio of next-generation products alongside our main tobacco business will provide us with significant new opportunities in the years ahead. We ended with share growth in the majority of our markets. Pricing remains good and our GDBs get stronger every year. While we cannot underestimate the challenges ahead in 2013, I am confident that we have robust plans in place and the resources to succeed. We have the momentum, proven capabilities and passionate people to deliver another year of good growth and I look forward to 2013 with optimism. highlights Our underlying overall market share grew Global Drive Brand volumes grew by 3% Innovations continue to drive growth Outstanding increase in operating margin by 160 basis points We have taken important steps forward in our plans to develop next-generation products Excellent overall financial performance Nicandro Durante Chief Executive Global Drive Brands performance Dunhill Kent Lucky Strike Pall Mall Cigarettes sold (billion) 49 Cigarettes sold (billion) 67 Cigarettes sold (billion) 33 Cigarettes sold (billion) 83 Volume growth +2% Volume growth +1% Volume growth +11% Volume growth +3% Number of markets 130+ Number of markets 90+ Number of markets 80+ Number of markets 110+ British American Tobacco Annual Report 7

10 Business Review Global market overview Global marketplace The value of the global tobacco market has been estimated at around 450 billion and the industry produces around 5.5 trillion cigarettes a year. While cigarette sales in developed countries continue to decline year-on-year, sustained volume growth is widely predicted in emerging markets, driven by population growth and increasing disposable income. As a result, the overall value of the tobacco market continues to grow. The biggest single tobacco market is China, where the industry is state-owned, with some 350 million smokers who account for more than 40% of global consumption. The four biggest international tobacco companies British American Tobacco, Imperial Tobacco, Japan Tobacco and Philip Morris International account for some 45% of the global market, or around three-quarters of the market outside China. Widely cultivated non-food crop Tobacco is one of the world s most widely cultivated crops, grown in more than 120 countries. The farmers who choose to grow it many in developing countries do so because it is hardy, grows well in poorer soils and volatile weather, and is known for fetching stable prices. Farmers can earn good yields from very small plots of tobacco and are able to grow other crops, such as food, often using the same land at different times of the year. The techniques used for growing quality tobacco can also be applied to growing these other crops. Less than 1% of the world s agricultural land is given over to tobacco farming and only for part of the year, yet it is an important contributor to the agricultural economy in many countries. Next-generation products Increasing prices and higher rates of excise make it ever more important that consumers are offered real value by the tobacco products they buy. Quality and innovation will both play an increasing role in delivering market share, as tobacco companies operate in a highly competitive marketplace. These innovations will include next-generation products: new-style tobacco and nicotine products that employ a range of new technologies. Substantial investments have been made in developing cigarette alternatives, including nicotine inhalation products, electronic cigarettes, aerosol nicotine-delivery systems and products that heat tobacco rather than burn it. The scientific community widely agrees that it is the toxicants in tobacco and tobacco smoke, not the nicotine, that causes the majority of tobacco-related diseases. Conventional cigarettes carry the most risks to health, while some forms of low-toxicant smokeless tobacco products, such as Swedish-style snus, although not risk-free, are much less risky. Regulatory-approved nicotine products that contain no tobacco or smoke toxicants are almost risk-free. The UK s Royal College of Physicians has said if nicotine could be provided in a form that is acceptable and effective as a cigarette substitute, millions of lives could be saved. We encourage tobacco companies, scientists and regulators to work together to ensure a science-based approach is used to assess new products that potentially pose less risk. This will provide consumers with the assurance that the product information they receive is based on sound science and allows them to make an informed choice based on the risk profile of different products. Tobacco s economic contribution The global tobacco industry contributes substantially to the economies of more than 100 countries, and millions of people worldwide depend on it for employment. Few industries are as wide-ranging and, for most countries, tobacco forms an important part of their economy and society. Even in countries that do not have tobacco manufacturing, tobacco retail and distribution is an important source of economic activity. And, of course, tobacco taxes are a major source of revenue for almost every government in the world for example, the UK government alone raised around 12 billion in excise and VAT on tobacco products in. It is estimated that governments worldwide collect in the region of US$250 billion in excise on the sale of tobacco products each year. Raising the debate on Twitter British American Tobacco s Twitter account Although we don t communicate about our brands and products, we do make our views known on a series of topical industry issues. We use Twitter to reach key stakeholders, such as journalists, opinion formers and members of the tobacco control community, on the topics that matter to us and our consumers. Follow 8 British American Tobacco Annual Report

11 Business Review Regulating the market Sound regulation is important in the tobacco industry and, where it is developed with all stakeholders involved, it can help to ensure an orderly marketplace that serves the interests of both consumers and governments. Tobacco farming a choice for millions of farmers Much of the tobacco regulation being proposed and introduced around the world is driven by the World Health Organization s Framework Convention on Tobacco Control. However, excessive regulation often has unintended consequences. Measures such as retail display bans and sudden increases in excise rates can distort competition among tobacco companies and, in some cases, may result in consumers switching to cheaper illegally trafficked products. Legislation enacted in to introduce plain packaging for tobacco products in Australia could affect the livelihoods of small retailers and make counterfeit products easier to produce and sell. It could also set a precedent for other consumer goods manufacturers and countries, as international trademarks are appropriated by local laws. This is why the Australian government s legislation has been challenged by member states of the World Trade Organization (WTO). The complaint, raised by three separate countries, will be considered by the WTO in 2013 and a ruling is expected in Trafficking of tobacco products Cigarettes are still among the most commonly trafficked products on the black market due to high profit margins, the relative ease of production and movement, along with low detection rates and penalties. It is a widespread problem that is made worse by excessive regulatory policies in some countries. British American Tobacco produced a short film in about tobacco farming and made it available on its corporate website and YouTube. Tobacco can grow in poorer soils and most climates and can easily be grown in rotation with food and other cash crops, helping farmers sustain a diversified income. The film explains how our local experts work with farmers, promoting stable livelihoods as well as helping to ensure social and environmental sustainability. You can view the film at or at Tobacco trafficking accounts for around 600 billion cigarettes sold every year. This trade has a negative impact on consumers, retailers, governments and tobacco companies. For consumers, counterfeit cigarettes mean no quality controls and no health warnings, while smuggled genuine products may carry health warnings that do not meet local government regulations. It is estimated that governments worldwide lose up to US$40 billion a year in excise and other taxes due to the trafficking of tobacco products. Meanwhile the profits end up in the hands of criminals who don t pay tax and sell their products to anyone, including children. This illegal trade can only be tackled effectively if the industry, regulators and enforcement authorities work together, supported by appropriate excise policies, sound regulation and effective enforcement. British American Tobacco Annual Report 9

12 Business Review Our strategy to deliver shareholder value Our strategy Our vision Our vision Our strategy Achieve leadership of the global tobacco industry Growth Our Group vision is to lead the global tobacco industry. We don t just measure that in volume and value, we also aim to be the world s best at meeting consumer needs. Productivity Winning organisation Responsibility Growth Productivity Winning organisation Responsibility We are consumer-led, providing high quality, relevant tobacco and next-generation products that meet consumer needs. We do this by being brand focused and excelling at bringing superior, differentiated offers to market. By effectively deploying our resources we can increase profits, improve our operating margin and invest in our business, helping us to grow market share and achieve higher returns for shareholders. We do this through our consumer-centric, flexible supply organisation and the implementation of a new global operating model with common systems and processes. British American Tobacco is a great place to work. We have great people and great teams. Our aim is to maintain a high performing organisation that can attract, develop and retain the next generation of leaders. We do this by being entrepreneurial and creating a culture of personal ownership. Our people are required to act ethically at all times and, as a business, we seek to reduce our environmental footprint and the harm caused by our products. To ensure we have a sustainable business, we engage with society through active, honest and open dialogue, while promoting a science-based approach to regulation that meets the needs of consumers. Read more in our strategic review on page 14 Read more in our strategic review on page 16 Read more in our strategic review on page 18 Read more in our strategic review on page British American Tobacco Annual Report

13 Business Review Key performance indicators Adjusted diluted earnings per share Adjusted diluted earnings per share (pence) % % +15% This is our adjusted diluted earnings per share (EPS) the detail of the calculation and the adjustments made are explained in note 7 on the financial statements. Target Our target is to grow adjusted diluted EPS at the rate of high single figures per annum, on average, over the medium to long term. Total shareholder return annual % FMCG group 1 January 2010 to 31 December The FMCG group comparison is based on three months average values (annual %) Upper quartile Lower quartile Median 15.0% British American Tobacco 23.1% The Group is focused on increasing shareholder value, which is measured using total shareholder return (TSR) compared to the FTSE 100 Index and also to a Fast Moving Consumer Goods (FMCG) peer group. The FMCG comparator group is reviewed annually to ensure that it remains both relevant and representative. TSR is measured according to the return index calculated by Datastream, on the basis of all companies dividends being reinvested in their shares. The return is the percentage increase in each company s index over a three-year period. FTSE January 2010 to 31 December The FTSE 100 comparison is based on three months average values (annual %) Upper quartile Lower quartile Median 9.2% British American Tobacco 23.1% British American Tobacco Annual Report 11

14 Business Review Our business model Our business model is designed to deliver sustainable growth in earnings for our shareholders. It is built around consumers and is supported by our consistent strategy, with growth and productivity driven by a winning organisation acting responsibly at all times. Achieve leadership of the global tobacco industry Growth How our strategy and business model work together Our strategy and business model drive our global operations, supported by a strong commitment to good corporate governance. We have world-class science, well-established brands and a range of product innovations that will deliver relevant benefits to consumers now and in future. All this contributes to a shareholder value proposition that continues to evolve but has a formidable track record of success in recent years. Productivity Winning organisation Responsibility Our business model delivering value Our consumer-centric approach to sourcing, production and distribution helps us to create value for a wider group of stakeholders throughout our products lifecycles. These include farmers and their communities, other suppliers, trade partners, governments and regulators. The quality of our people is a crucial factor in delivering this and our global presence enables us to leverage the value they create on a worldwide scale. Productivity Brands Growth Innovation Delivering World-class value science Our consumer-centric approach to sourcing, production and distribution helps us to create value for a wider group of stakeholders throughout our products lifecycles. These include farmers and their communities, other suppliers, trade partners, governments and regulators. The Consumers quality of our people is a crucial factor in delivering this and our global presence Sourcing Distribution Production Our people Responsibility Global presence Winning organisation 12 British American Tobacco Annual Report

15 Business Review World-class science For over 50 years, we have had an extensive scientific research programme. More recently, we have been focusing research on innovative low-toxicant smokeless tobacco and nicotine-based products for adult smokers who want a safer alternative to cigarettes. Our work with scientists and public health professionals aims to secure widespread support for tobacco harm reduction, including the regulatory changes needed to support bringing reduced-risk products to market. Brands We have a successful brand marketing strategy based on our insights of the consumer. Our portfolio of more than 200 global, regional and local brands is designed to meet key consumer preferences, wherever they are in the world. Our Global Drive Brands Dunhill, Kent, Lucky Strike and Pall Mall have enjoyed considerable success and today account for one in three of the cigarettes we sell. Our aim is to offer a tailored brand solution for every relevant consumer segment. Innovation We make significant investment in research and development to deliver innovations that satisfy or anticipate consumer needs and generate growth for the business. This involves innovations such as capsule products, all natural products and Reloc, our resealable pack technology. We also look outside the traditional cigarette market and research, develop and test new products to meet changing consumer needs. We continue to review potential acquisitions that will complement our in-house research or increase our speed to market. Our people We employ more than 55,000 people worldwide from securing our leaf supply through production and distribution to our efforts to develop reduced-risk products. Our workforce is strongly multi-cultural and we have a devolved structure, with each local company having responsibility for its operations. We encourage a culture of personal ownership and value our employees talents. Their diverse perspectives help us to succeed and we recognise their critical role in achieving the goals we set for our business. Consumers We place consumers at the heart of our business. We invest in world-class research to understand changing consumer needs and buying behaviour, creating brands and innovative products that will fulfil these needs. This drives our supply chain, our product development, our innovations, our brands and our trade activities. It is our aim to satisfy consumers while addressing stakeholder concerns and expectations about how we should market our products. Global presence Our business was born international and, with 110 years of operating globally behind us, today we are one of the world s leading tobacco groups. Our brands are sold in around 180 markets and our geographic diversity and strong positions in emerging markets are key strengths. We hold robust market positions in each of our regions and have leadership in more than 60 markets. With over 200 brands in our portfolio, we make the cigarette chosen by one in eight of the world s one billion adult smokers. Sourcing We have a significant interest in tobacco growing and we provide agronomy support to over 100,000 directly contracted farmers. We manage our whole supply chain responsibly, both leaf and other materials used across our business, and work with suppliers to create a shared understanding of our social, environmental and economic impacts. This enables us and our suppliers to manage risks better, while ensuring that we are agile and flexible, using our resources as effectively as possible. Production Manufacturing tobacco products is a large-scale operation and we have state-of-the-art manufacturing facilities all over the world. We work to ensure that our costs are globally competitive and that we use our resources as effectively as possible. Our companies have consolidated their production facilities in recent years to ensure that we can meet the needs of an agile and flexible supply chain rationalising our machinery and technology to establish a more cost-effective and world-class operational base for the future. Distribution Our well-developed distribution channels are critical enablers of our growth strategy, allowing us to roll out innovations on a global scale. We continuously review our route to market to ensure we remain competitive. This includes our relationships with wholesalers, distributors and logistics providers, as well as our direct to store sales operation. Almost half of our global volume is now sold through retailers supplied through our direct distribution capability or exclusive distributors. British American Tobacco Annual Report 13

16 Business Review Strategic review Growth We continued to achieve sustainable, profitable growth in, driven by continued pricing momentum despite a difficult economic environment. This was underpinned by a strong brand portfolio, innovative launches and good pricing. Strong growth driven by GDBs Overall GDB volume grew by 3% in (or by 4% excluding the impact of Japan), driven by the expansion of GDBs into new and established markets, as well as the roll-out of consumer-relevant innovations. The GDB share of global volumes has increased from 18% to 33% since 2005, driven by our innovations. In we remained the market leader for capsule products, with a segment share of over 50% in our key markets. Dunhill, our most prestigious brand, delivered organic growth in across most of our key markets, including Indonesia, Malaysia, the Gulf Cooperation Council (GCC), South Africa, Taiwan and Romania, driven primarily by innovation. Despite the difficult competitive environment in South Korea, total Dunhill volume increased by 2% in to reach 49 billion cigarettes. Dunhill continued to deploy the Reloc seal across its ranges, with 62% of all Dunhill cigarettes now sold in this innovative packaging. Dunhill also grew across Indonesia, South Africa, Hungary, Romania and Malaysia, helping the brand to reach record volumes in. Kent continued its strong growth in eastern Europe and the Middle East in. Global volume grew by 1% to 67 billion cigarettes; 4% excluding the impact of Japan. This robust performance was achieved through share gains in key markets such as Ukraine, Vietnam and other eastern European and Middle East markets. Kent Convertibles, the innovative range of capsule products launched in 2010, is now available in 26 markets. An upgrade in both product and packaging design in resulted in an increase in volume of over 30% for this range. The further development of Kent s HD range also delivered strong volume performance in Russia. Lucky Strike had another outstanding year with double-digit growth of 11%. A record volume of 33 billion cigarettes was sold in due to strong performances in Argentina, Chile, France and Germany. This level of growth was achieved despite the general market decline in the key Lucky Strike markets of Spain and Italy. Lucky Strike s growth continued to come from both capsule technology and the new all natural offer. There were almost twice as many capsule cigarettes sold compared to last year and the all natural offer more than tripled sales within the same period. These two products accounted for more than 22% of all Lucky Strike cigarettes sold. Pall Mall, our number one volume brand, delivered growth of 3% in. Significant growth came from Pakistan, Germany, Canada, Romania, Russia and the UK. Across our GDBs, Fine Cut roll-your-own and make-your-own tobacco volumes grew in Western Europe by nearly 30% in. Pall Mall posted impressive results with increased volumes of 18% and a strong performance throughout the region. Lucky Strike more than doubled its volumes, driven by new launches. Strong performance of international brands In addition to our GDBs we have a strong portfolio of international brands such as Rothmans, Peter Stuyvesant, Craven A and John Player Gold Leaf. Rothmans had a very good year on the back of a new launch in Russia and grew 4% globally. This was despite reduced volumes in Egypt due to increased illicit trade, and the brand continued to grow in the Middle East, Nigeria, North Africa, Italy and the UK. Viceroy volumes were down in due mainly to a decline in Turkey. Vogue volumes also fell in driven by a decline in Russia, however the brand grew in key Western Europe markets such as Romania and Germany. John Player Gold Leaf, our key regional brand in Asia-Pacific and the Middle East, posted good growth with improved performance in its key markets of Pakistan, Bangladesh and the GCC. Benson & Hedges saw good growth in many markets, but overall the brand was adversely impacted by market declines in Australia and Nigeria. Craven A, our regional brand in Asia-Pacific and Eastern Europe, Middle East and Africa (EEMEA), had a great year with double-digit growth of 11% and an improved performance in all of its key markets. Underlying performance of Kool was good, although the brand declined due to the high comparator caused by the impact of the out-of-stocks in Japan in. Peter Stuyvesant delivered higher volumes in mainly due to a stable performance in South Africa and growth in other EEMEA markets. Trade marketing and distribution We have around 10,000 Trade Marketing & Distribution (TM&D) employees responsible for the selling and delivery of our products, the presence and activation of our brands at the point of sale and the development of mutually beneficial partnerships with our customers. This includes engagement in the prevention of youth smoking and illicit trade. Developing the field force To successfully support our brands and innovations in a fast-paced and rapidly changing environment, Positive, a new ambitious programme to train and develop our people is being rolled out globally. The programme provides our people with a competitive edge and ensures we continue to meet the demands of customers and consumers. 14 British American Tobacco Annual Report

17 Business Review Route to market Our route to market is critical to meet consumer demand at the point of sale and allows us to roll out brand initiatives and innovations quickly and on a global scale. Where appropriate, we believe that direct-to-store sales (DSS) are an effective way of serving retailers and building sustainable business partnerships. DSS gives us visibility and control over the sales and distribution process, allowing us access to both the market and consumer information. It also provides a direct commercial link to our most strategic retail accounts. In we further enhanced our capabilities with investments in a number of markets including Indonesia and South Africa. We also work with exclusive distributors to ensure our products are effectively sold and delivered to retailers, and almost half of our global volume is sold to retailers through these distributors and through our own distribution capability. Customer management Building partnerships with retailers is a key part of our trade marketing activities. We work closely with our retail partners to provide support and ensure that at all times they can profitably meet the expectations of adult smokers with regards to availability, pricing and brand quality. This includes the development of effective trading terms, which are a key foundation of a successful partnership. Key performance indicators (KPIs) Group s share of key subsidiary markets (increase in % share)* This is our retail market share in the Group s Top 40 markets which cover around 80% of the volumes of subsidiaries. The information used in this calculation is based on publicly available information and internal company analysis. Target Our target is to continue to grow market share. * Share figures are rebased annually to reflect market and segment size changes. The figure has been rebased to reflect the one-off impact of out-of-stocks in Japan in. +0.1% Global Drive Brand (GDB) volumes GDB volumes are calculated as the total volumes of the four GDBs Dunhill, Kent, Lucky Strike and Pall Mall sold by our subsidiaries. Target Our target is to increase our GDB share faster than the rest of our portfolio. 232bn (+3%) Business measures Total cigarette volumes Total cigarette volumes are defined as all cigarettes sold by our subsidiaries. Objective Our objective is to maintain or grow our total volumes. 694bn (-1.6%) British American Tobacco Annual Report 15

18 Business Review Productivity Productivity continues to be an important part of our strategy. It provides the capabilities and resources we need to support investment in our brands so that we can grow share in our key markets. Our globally-integrated supply chain continues to improve efficiency and effectiveness while we are making our operations flexible, agile and truly consumer-centric. Our ability to roll out innovations with speed is evolving and we continue to leverage our scale. Productivity savings Cost management remains a focus across the business, and has helped to deliver an improved operating margin of 37.4%. We have also continued to improve our marketing efficiency and capital effectiveness, including reducing unnecessary complexity to save costs and using our cash and assets more effectively. We continue to realise productivity savings from the supply chain, including indirect material procurement and overhead savings, ensuring the Group is able to invest in product enhancements and capabilities that enhance the consumer experience. New operating model In the Group began a medium-term programme to implement a new operating model. This includes revised organisational structures, standardised processes and shared back-office services, underpinned by a global, single instance of SAP. The new structures and processes are currently being implemented and the deployment of the new SAP system started in the third quarter of. This will take around four years to fully roll out. Optimising resource allocation Our integrated supply chain enables the group to deliver growth. The transparency of demand and supply at a global level through sales and operational planning ensures we are able to deliver faster and better decision making to allocate resources. This has also allowed us to roll out innovations faster and implement machine technology standards improving our sourcing flexibility, contingency planning and capital effectiveness. Global supply chain network In we continued to optimise our manufacturing footprint. Over the past 10 years we have reduced the number of cigarette factories from 87 to 44 in 39 countries, including acquisitions. Further closures, including at Bremen in Germany, have progressed in line with expectations, while the restructuring of Boncourt in Switzerland and Vranje in Serbia were announced during the year. Investment to support continued growth ensured manufacturing sites were optimised to deliver anticipated volumes, coordinated across our global network. Consolidation of factories around the Group continues to be undertaken responsibly and with care for affected employees and local communities. Our key factories now generally serve multiple portfolios and markets, managed through our above-market planning capability. We are also developing industry-wide supply chain security systems with other international tobacco companies. This will include identifiers that will allow consumers and authorities to validate a product s authenticity, and digital coding technology to help governments ensure that all taxes and duties are paid. Our track and trace technology, which allows us to monitor the movement of our products within the supply chain, was implemented in Russia, Poland, Ukraine and Belarus by the end of and is currently being introduced in Germany and Romania. Procurement joint venture Agrega, our procurement joint venture with AB InBev, continues to expand its geographic reach, leverage scale and build expertise in indirect spend. Leaf supply chain Our leaf supply chain is the most vertically integrated in the industry and continues to provide a competitive advantage, global visibility and cost efficiencies through the quality of our leaf, our people and through our relationships with farmers. Our proven expertise in leaf gives us a strong position to address new consumer needs and the effects of product-based regulation. We are managing our leaf footprint to ensure sustainability of supply and guaranteeing access to quality sources of leaf. 16 British American Tobacco Annual Report

19 Business Review Key performance indicators (KPIs) Adjusted profit from operations at constant exchange rates Profit used in this assessment is the adjusted profit from operations of the Group s subsidiaries adjusted profit from operations at constant rates for the items shown as memorandum information on the Group Income Statement. Target The Group s medium to long-term target is to grow adjusted profit from operations on average by 6% per annum. 5,970m (+8%) Cash generated from operations Cash flow from operations is defined as the free cash flow excluding restructuring costs and dividends and other appropriations from associates, per the alternative cash flow on page 35. Target A specific target is set each year for the cash flow from operations. The target for was exceeded. 2,739m Business measures Operating margin This is the percentage of adjusted profit from operations divided by revenue. Objective Our objective is to increase operating margin by basis points per annum. 37.4% Free cash flow as a percentage of adjusted earnings This measures our free cash flow as a ratio of the adjusted earnings. Objective Our objective is to maintain a percentage figure over 80%. 81% British American Tobacco Annual Report 17

20 Business Review Winning organisation Diversity We pride ourselves on having a diverse workforce who meet the needs of our diverse consumers, customers, suppliers and other stakeholders. We have 64 nationalities working at our global headquarters in the UK. We are committed to improving the diversity of our senior management teams, including by gender and by nationality. Local staff account for an average of 62% of employees on top teams around the world, an increase from 57% last year. We are also supporting the career development of female managers to increase the number of women in senior roles. In, the number of women in management roles remained steady at 32% and we had 25% female Board representation. We are dedicated to providing equal opportunities to each employee. We do not discriminate when making decisions on hiring, promotion or retirement and we are committed to providing training and development for employees with disabilities. Employee opinion survey Your Voice is our employee opinion survey that we carry out every two years to measure employee satisfaction and engagement. In we updated the survey to better meet our business needs and priorities, and 42,932 employees completed the survey, which was translated into 48 languages. The results help us to understand how our employees view us and any issues they have. In this latest survey, 80% said they were extremely satisfied with British American Tobacco as a place to work, well above the benchmark of 71% in the fast moving consumer goods (FMCG) sector. Our functions, regions and local companies are turning the detailed feedback from the survey into plans to address areas for improvement. The survey also allows us to determine our overall employee engagement index score. Broadly, this score combines employee satisfaction with our employees attitudes towards recommending British American Tobacco as a place to work, their desire to stay with the organisation and their pride in working for us. Our employee engagement index score of 72% in met our objective of scoring more favourably than the FMCG norm (68%). Employee engagement British American Tobacco is committed to employee engagement throughout the business and this includes acting on areas identified as needing improvement in our employee survey. Employees are kept well informed of the strategy, performance and objectives of the Group through communication cascades at key points in the year, which involve video broadcasts from the Chief Executive, face-to-face presentations and Q&A discussions. Global, regional and local intranets, web-based meetings and presentations, and electronic employee magazines also provide important information, while feedback is encouraged through open forums and Q&A sessions. Our Sharesave Scheme, our Partnership Share Scheme and our Share Reward Scheme are open to all UK employees. We also operate several similar schemes for senior management in our end markets. Business measures Employee engagement index Our Your Voice employee opinion survey was updated in to better meet our business priorities. This has enabled us to change the business measure and focus it more specifically on our engagement index a measure that reflects employee satisfaction, advocacy and pride in the organisation. Objective Our objective is to achieve a more positive score than the norm for the fast moving consumer goods companies in our comparator benchmark group. In, our engagement index score was 72%, compared to a norm of 68% for our comparator group. 72% 18 British American Tobacco Annual Report

21 Business Review Responsibility In our industry it is particularly important that we act responsibly, demonstrate openness and build trust. We do this by managing the impact of our operations and products responsibly. This is backed up by transparent and independently assured reporting, regular stakeholder engagement and sound governance procedures. We continue to address our social, environmental and economic impacts to build value for the business, for our shareholders and for all the wider stakeholders affected by our business. To help us do this, we will be redefining our sustainability agenda; there is more information about this in our sustainability overview on page 22. Our Business Principles and our Standards of Business Conduct set out what we require of our companies and our employees in terms of responsible corporate behaviour and personal integrity. And we support regulation that maintains a balance between consumer preferences and the interests of society, while also enabling our business to continue to compete commercially. Research & development Our Group Research & Development (R&D) activities are focused on our harm reduction efforts but also encompass the exploration of new products and innovative technologies. Group R&D also provides guidance on the use of ingredients to ensure our products comply with national legislative requirements and our own Group standards. Our principal R&D facilities are located in Southampton and Cambridge in the UK and at Cachoeirinha in Brazil. In, total investment in Group R&D, including marketing innovations and Nicoventures, was 171 million, compared to 166 million in. In we gave presentations at a number of scientific conferences, including the American Association for the Advancement of Science, and submitted 29 research papers for publication in peer-reviewed journals. To increase the transparency of our science we make our research publicly available on our dedicated science website As part of our research into tobacco harm reduction we are exploring a range of reduced-risk tobacco and nicotine products. In, we completed the clinical phase of a study to measure biomarkers of biological effect that could indicate changes in the body relating to disease processes. Regulatory-approved nicotine products, as an alternative to conventional cigarettes, offer significantly reduced health risks. Our subsidiary Nicoventures is preparing to launch a nicotine inhalation product that, subject to regulatory approval, could provide smokers with a safer alternative to cigarettes. In addition, in we acquired CN Creative, a UK-based company that specialises in the development of electronic cigarette (e-cigarette) technologies intended to offer smokers less risky alternatives to cigarettes. This is a natural extension of our long-term commitment to tobacco harm reduction. Responsible marketing Wherever we do business around the world, our companies marketing is governed by our International Marketing Principles. They were launched at the end of and provide a consistent and responsible approach to marketing across the Group, replacing our International Marketing Standards which were launched in 2001 and updated in The updated International Marketing Principles reflect developments in marketing, technology, regulation and stakeholder expectations and are available at We are committed to 100% compliance to our International Marketing Principles, and immediate action is taken in response to any reported breaches. Environmental performance We are working to address both our immediate environmental impacts and the likely environmental pressures on the business in the future. This involves risk assessments, performance management and making our operations more efficient. Our key focus is on minimising energy consumption, reducing our carbon footprint and securing the resources we need for the long term. To assess our environmental efficiency, we set targets relative to the volume of cigarettes we produce. To measure and manage our future environmental performance, in we developed new five-year targets for CO 2 e, energy and water use, as well as year-on-year targets for waste. You can read more about our new targets for 2013 and beyond online at www. bat.com/sustainability/data. Afforestation Our afforestation programmes encourage tree planting to provide a sustainable source of wood for farmers who require it for tobacco curing. Our aim is to reduce the use of natural forests for curing by directly contracted farmers to zero by In, we made progress towards this target, with a fall from 7.3% to 4.0% of wood used by these farmers. Since 2007 we have planted 140 million trees. Biodiversity Our Biodiversity Risk and Opportunity Assessment (BROA) tool helps our companies protect and improve biodiversity in and around tobacco farms. In, we rolled out an updated version of the BROA tool to all our leaf growing operations. The next round of assessments will be completed by the end of Since 2001 we have worked with Earthwatch, Fauna & Flora International and the Tropical Biology Association in the British American Tobacco Biodiversity Partnership. The Partnership seeks to address some of the challenging issues surrounding the conservation and management of biodiversity within agricultural landscapes and the ecosystems on which we depend. British American Tobacco Annual Report 19

22 Business Review Responsibility (continued) Human rights We recognise that we have a role in addressing human rights issues and we use our influence with our suppliers to improve conditions in our supply chain. In, we reviewed our approach, drawing on the UN Universal Declaration of Human Rights and the Organisation for Economic Cooperation and Development s (OECD s) Guidelines for Multinational Enterprises. Human rights criteria are incorporated into our major supply chain management programmes, including our Business Enabler Survey Tool and our Social Responsibility in Tobacco Production programme. Our suppliers are required to meet criteria on issues including workers rights and child labour, and we are incorporating human rights criteria into all our framework agreements with global suppliers. We also encourage compliance with Group policy and local laws. Child labour is an important issue for an industry like ours with an agricultural supply chain. In 2001 we helped to establish the Eliminating Child Labour in Tobacco Growing (ECLT) Foundation and we support it actively as a founding member, helping communities understand child labour issues and improving access to education and health services for children. Corporate social investment Our corporate social investment (CSI) activities include a range of community and charitable projects, centred on empowerment, civic life, environment and sustainable agriculture. This means giving people training, education and opportunities to help them develop; promoting activities that aim to enrich public and community life; and making meaningful contributions to local agriculture. Our global CSI expenditure in was 11.6 million (: 13.7 million) as defined by the statutory reporting criteria for charitable donations. Health and safety We are committed to providing a safe place to work for all employees and contractors. In, we strengthened our accident review processes and launched Closing the gap to zero, our global awareness campaign. This campaign was led by our Chief Executive and Group Operations Director. Following targeted initiatives, we saw fewer accidents than the previous year in all six most common causes of accidents. We also reduced the number of reported lost workday cases across the Group by 20%. Regrettably, we suffered an increase in serious injuries and fatalities to our employees and contractors working in some of the more challenging environments around the world. Reported serious injuries increased from 30 to 43 and fatalities from seven to 12. The rise in fatalities was mainly due to an increase in assaults on our sales representatives and security guards and serious road traffic accidents. Detailed reviews of each incident are undertaken to learn lessons and identify actions for the future. Business measures Carbon dioxide equivalent (CO 2 e) (tonnes CO 2 e per million cigarettes equivalent produced) CO 2 e is largely derived from energy consumption and we track this in tonnes per million cigarettes equivalent produced. The figure includes the performance data for the business we acquired in Colombia in October. Objective Our objective is to reduce Group CO 2 e by 50% by 2030 from our 2000 baseline of 1.38 and by 80% by lower than (41% 2000 baseline) Group energy use (gigajoules per million cigarettes equivalent produced) This measure tracks Group energy use in gigajoules per million cigarettes equivalent produced. Group energy use is the energy used by the Group in its own operations, business travel and freight. We do not include energy used to produce and deliver purchased energy. The figure includes the performance data for the business we acquired in Colombia in October. Objective Our objective is to reduce energy use to 9.82 by 2017, 17% lower than our 2007 baseline lower than (13% ) 2007 baseline 20 British American Tobacco Annual Report

23 Business Review Business measures Water use (cubic metres per million cigarettes equivalent produced) This measure tracks Group water use in cubic metres per million cigarettes equivalent produced. The figure includes the performance data for the business we acquired in Colombia in October. Objective Our objective is to reduce water use to 3.6 by 2017, 26% lower than our 2007 baseline lower than (22% 2007 baseline) Waste to landfill (tonnes per million cigarettes equivalent produced) This measure tracks Group waste sent to landfill in tonnes per million cigarettes equivalent produced. The figure includes the performance data for the business we acquired in Colombia in October. Objective Our objective is to sustain waste sent to landfill at no more than tonnes per million cigarettes equivalent produced, 36% lower than our 2007 baseline lower than (52% 2007 baseline ) Recycling (percentage of waste recycled) This measure tracks the total percentage of Group waste re-used or recycled against total waste generated. Objective Our objective is to recycle more than 85% of waste generated in each year. 92.5% The figure includes the performance data for the business we acquired in Colombia in October. Lost Workday Case Incident Rate (LWCIR) The LWCIR is a standard health and safety measure that helps us measure working days lost through injury on a consistent basis year-on-year. Objective The local target set for all of our companies is zero accidents, and we have a zero accidents ambition for the whole group LWCIR: Lost workday cases through injury x 200,000 total hours worked. For more information on our environmental objectives and to access our Sustainability Data Centre, visit the Sustainability section of our website. British American Tobacco Annual Report 21

24 Business Review Sustainability overview Our vision of a sustainable tobacco business is one that manages the impact of its operations and products responsibly today and prepares for a future in which it continues to create value for shareholders as well as being in the best interest of other stakeholders. Our approach to sustainability We were the first tobacco company to publish a social report and our approach to sustainability has been reviewed and refined ever since. Our sustainability agenda today focuses on the five areas of harm reduction, marketplace, supply chain, environment and people and culture all of which we describe in this section, highlighting our key priorities and issues. In, we began work on a brand new sustainability agenda that increases our ambition and better measures our impacts. The key areas of our current sustainability agenda will continue to be important, but we want to focus more specifically on the issues that have the greatest bearing on society. We will be working with stakeholders to develop our plans and we will report on this in our Annual Report Sustainability reporting We are also changing the way we report this year away from a single annual Sustainability Report towards a more integrated approach across our Annual Report and our corporate website, We are still producing a Sustainability Summary report, published at the same time as this Annual Report, outlining our performance and key issues. We will also be producing more focused sustainability communications, including two issuespecific reports later in 2013 to provide stakeholders with more in-depth information on the topics that interest them most. You will find specific performance indicators relating to our sustainability focus areas within the main strategic review in this report. Detailed performance data for is available at You can also read more about our activities and view our sustainability video online at Stakeholder engagement Our stakeholders include investors, NGOs, regulators, suppliers, the scientific and public health communities, consumers, employees, local communities, customers (retailers and distributors) and sustainability opinion leaders. In short, anyone who is impacted by, or can impact upon, our business operations is a stakeholder of British American Tobacco. Engaging with our stakeholders helps us to understand their concerns and therefore to respond to them appropriately. It gives us valuable feedback on our policies, procedures and ways of working, so that we can continually improve them. It provides us with opportunities to put our views across, helping our stakeholders understand our positions. Materiality Over the years, we have always focused our sustainability reporting on those issues of the greatest significance to our business and our stakeholders. However, in 2007, we began taking a more systematic approach to identifying those issues. Following a review of our companies stakeholder dialogue sessions since 2001, we drew up a list of key topics and grouped them into categories to help us establish which were the most significant. The materiality process involved internal consultation with regional teams and senior functional managers in relevant areas, as well as the Management Board and the Board CSR Committee. Finally, we discussed a refined list of key topics with sustainability opinion leaders and relevant NGOs. The end result was the identification of our current focus areas: harm reduction, marketplace, supply chain, environment and people and culture. We continue to review our materiality process each year and, in 2013, this review will support our work in redefining our sustainability agenda. Sustainability assurance statement from Ernst & Young Some of the data used in the Strategic review in this Report has been reviewed by Ernst & Young LLP as part of their process for providing assurance of British American Tobacco s sustainability reporting for. This includes data on pages relating to environmental performance, health and safety, our employee opinion survey Your Voice scores and diversity. You can read Ernst & Young s full assurance statement at 22 British American Tobacco Annual Report

25 Business Review Harm reduction We know tobacco products pose real and serious health risks and the only way to avoid these risks is not to use them. But many adults choose to smoke, so our top priority continues to be working towards reducing these risks and making available a range of less risky tobacco and nicotine-based alternatives. Our research and development programme is focusing on tobacco harm reduction and we are exploring a range of reduced-risk tobacco and nicotine products. This includes a nicotine inhalation product being prepared for launch in the UK by our subsidiary Nicoventures and exploring innovative electronic cigarette technologies through our recent acquisition of CN Creative. Our work with scientists and public health professionals aims to secure widespread support for tobacco harm reduction, including the regulatory changes needed to support bringing reduced-risk products to market. Environment We are working to reduce our environmental impacts as we aim for stretching 2030 and 2050 carbon reduction targets. In, we also developed new five-year targets for CO 2 e, energy and water use, as well as year-on-year targets for waste. These targets can be viewed online at sustainability/data, where you can also find more details of our performance in against our key measures. To help achieve our challenging new targets, we will be rolling out a number of energy and CO 2 e reduction projects in 2013, and will continue to explore renewable and low carbon energy options for the longer term. We will also be conducting detailed assessments of long-term water supply and demand requirements in the high-risk places we operate in. Marketplace We are proud of the way we do business and we aim always to be open and honest about our views and activities within the marketplace. Like any business, we want to grow our market share. But we want to do this by encouraging existing adult smokers to choose our products over those of our competitors, not by trying to increase the number of people who smoke or how much they smoke. Given the serious negative health impacts of tobacco products, we support balanced regulation and we expect high standards of corporate conduct among those who produce, distribute, market and sell them. To achieve this we focus on three key areas: engaging with stakeholders on industry regulation; responsible marketing and preventing underage access; and fighting the black market in tobacco. People and culture Our reputation as a leading employer helps us stand out in an increasingly competitive international employment market, and our people are key to delivering our strategy. Our focus is on: driving high performance; developing the next generation of leaders; valuing the diversity of our employees; encouraging and rewarding entrepreneurial behaviour; and creating an engaging culture where individuals and teams can be successful. Providing a safe place to work, protecting our employees wellbeing and listening to their views are also fundamental. We want a stretching and supportive culture founded on personal commitment and responsibility that attracts, engages and retains the most talented and diverse people. Supply chain We rely on a complex but critical supply chain and we need it to be fit for the future. We are using our influence to improve sustainability from crop to consumer. We manage the impacts of our business through our own activities and those of our supply chain. Our environmental management systems meet best international standards and we developed our supply chain sustainability strategy with the help of our internal and external stakeholders. We don t own tobacco farms, but we provide agronomy support through our extension services to over 100,000 directly contracted farmers. Our Social Responsibility in Tobacco Production programme encourages continual improvement of the social and environmental performance of the suppliers we buy tobacco leaf from. SUSTAINABILITY Why it matters SUSTAINABILITY SUMMARY British American Tobacco Annual Report 23

26 Business Review Chief Operating Officer s review The Group delivered a very good performance in. Exchange rate movements, especially the euro, Brazilian real, South African rand and Russian rouble, had an adverse impact on reported results. Reported revenue was 1% lower. At constant rates of exchange, revenue was 4% higher, reflecting continued good pricing momentum. The reported profit from operations was 15% higher at 5,412 million, with a 3% increase in adjusted profit from operations. At constant rates of exchange, the adjusted profit was 8% higher. Group volumes from subsidiaries were 694 billion, down by 11 billion or 1.6%. This was principally as a result of industry volume declines in Western Europe, Brazil and Egypt, together with volume losses in low value brands in Indonesia and Turkey. Organic volumes were down 2.0% or 1.7%, excluding the effect of the one-off comparator in Japan in. highlights All four regions increased operating margin, contributing to an excellent increase of 160 basis points to 37.4%. GDB volumes are now one-third of our total global volumes. Pall Mall is the largest Fine Cut brand in Western Europe. Group volumes were 694 billion, down 1.6%, mainly due to contractions in some of our larger markets. Other tobacco products performed well. Fine Cut tobacco grew by 8% to 14,494 tonnes in Western Europe, mainly in Germany, Spain, the United Kingdom, the Netherlands and Italy. Market share was up strongly and profit was higher. Pall Mall is by far the largest Fine Cut brand in Western Europe. The four Global Drive Brands (GDB) achieved good overall volume growth of 3% and increased market share by 30 basis points, driven by the successful roll-out of innovations. GDBs now account for over one-third of total volumes. Dunhill volumes increased by 2% as strong growth in Indonesia, Malaysia, South Africa, Romania, Hungary and Chile was partially offset by a decline in South Korea. Kent was 1% higher than last year with increased volumes in Ukraine, Russia, Azerbaijan and Vietnam, offset by reduced volumes in Japan. Adjusting for the one-off comparator in Japan, Kent grew by 4%. Lucky Strike increased volumes by 11% with growth in Argentina, France, Germany and Chile. Pall Mall volumes rose by 3%, with outstanding growth in Pakistan and increases in Canada, Romania and the United Kingdom partially offset by lower volumes in Italy, Spain and Uzbekistan. John Daly Chief Operating Officer 24 British American Tobacco Annual Report

27 Business Review Our regional performance Americas 23% Share of Group revenue Western Europe 23% Share of Group revenue EEMEA 27% Share of Group revenue Asia-Pacific 27% Share of Group revenue Revenue () Adjusted profit () Volume (bn) Asia-Pacific 4,214 : 4,251 1,666 : 1, : 191 Americas 3,460 : 3,558 1,415 : 1, : 143 Western Europe 3,442 : 3,600 1,186 : 1, : 135 Eastern Europe, Middle East and Africa (EEMEA) 4,074 : 3,990 1,414 : 1, : 236 Notes: Profit discussed in the regional review is based on adjusted profit from operations and therefore excludes the impact of restructuring and integration costs, amortisation and impairment of trademarks and similar intangibles, goodwill impairment, exceptional provisions and gains on disposal of businesses and trademarks. Volumes change percentages, where shown in the Report, are based on the absolute numbers. British American Tobacco Annual Report 25